1. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-1 Chapter 22 Managing an International Investment Portfolio 22.1Vehicles for Overcoming Capital Flow Barriers 22.2Share Prices in International Markets 22.3Asset Allocation Policy and Investment Style 22.4Cross-Border Financial Statement Analysis 22.5The Shifting Sands of Portfolio Analysis 22.6Portfolio Hedging Strategies 22.7Summary

2. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-2 Overcoming capital flow barriers  Domestic-based MNCs - Advantage Domestically-based MNCs are familiar and accessible to domestic investors - Disadvantage MNC share prices move more closely with the domestic stock market than with international markets

3. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-3 Overcoming capital flow barriers  Domestic-based MNCs  Individual foreign securities - Direct purchase in the foreign market - Direct purchase in the domestic market - Foreign shares (American shares in the US) - Depository receipts (ADRs in the US)

4. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-4 Overcoming capital flow barriers  Domestic-based MNCs  Individual foreign securities  Mutual funds of foreign assets - Mutual funds (open-end or closed-end) - Many mutual funds are exchange-listed - Closed-end country funds (CECFs) - CECFs trading on the NYSE include Brazil, Germany, Italy, India, Korea, Mexico, Malaysia, S. Africa, Spain, Switzerland, Taiwan, Thailand, UK

5. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-5 Overcoming capital flow barriers  Domestic-based MNCs  Individual foreign securities  Mutual funds of foreign assets  Hedge funds - Private investment partnerships - In the U.S., hedge funds have a general manager, fewer than 100 limited partners, and are not regulated by the SEC

6. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-6 Hedge fund strategies  A wide variety… - Emerging markets - Market-neutral - Opportunistic - Short-selling - Small-cap - Special situations - Value - Arbitrage e.g., yield-curve arbitrage

7. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-7 Overcoming capital flow barriers  Domestic-based MNCs  Individual foreign securities  Mutual funds of foreign assets  Hedge funds  Other international investment vehicles - Equity-linked bonds - Index futures, options or swaps

8. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-8 Share prices in restricted markets  Governments allow restricted access to their financial markets through - Closed-end country funds (CECFs) (mutual funds invested in a single country) - Unrestricted shares sold internationally (only domestic investors can hold restricted shares )  CECFs and unrestricted shares can trade at substantial premiums to net asset value (NAV)

9. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-9  International asset pricing with investment restrictions - A classic portfolio maximization argument - Assumes rational investors maximizing the mean-variance efficiency of their portfolios Explanations for share prices in segmented markets

10. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-10 Explanations for share prices in segmented markets  International asset pricing with investment restrictions  Investor sentiment - Individual investors trade on their (possibly irrational) sentiment regarding future returns and risks - Premiums are large when foreign investor demand is high

11. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-11 Portfolio investment styles  Asset allocation policy - A fund’s target weights on various asset classes  Investment philosophy - Passive fund management - Benchmarked to an index - Active fund management - Active asset allocation - Active security selection

12. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-12 The market timer’s penalty Market timer’s penalty for random switches between Hong Kong and U.S. stocks US HK Buy-and-hold investor Naive market timer

13. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-13 Financial accounting measurement  Cross-country financial statement analysis is difficult because of national differences in the measurement of accounting income - Differences show up in the construction of nearly every financial account - National accounting differences can result in huge differences in reported income

14. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-14  There are also cross-border differences in financial disclosure requirements  Alternatives for providing financial information to investors in another country - Do nothing - Prepare convenience translations - Using different accounting principles, such as IAS standards, in preparing the firm’s financial statements Financial accounting disclosure

15. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-15  Inputs to portfolio analysis E[r P ] =  i X i E[r i ]  P 2 =  i  j X i X j  ij  The shifting sands of portfolio analysis - Time-varying expected returns & risk premia - Time-varying volatilities - Time-varying correlations Portfolio analysis

16. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-16 Time-varying volatility, 1970-2002 Canada Japan United Kingdom United States

17. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-17 60-month rolling correlations with the U.S. stock market

18. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-18 Returns during the crash of 1987

19. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-19 When it rains, it pours…  Fact Observed correlations are higher during market downturns than conventional models predict  Consequence International diversification may fail to yield its promised gains just when they are most needed

20. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-20 Stock market correlations in bear, calm, and bull markets

21. Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 22-21 Adapted from “Asset Allocation with Hedged and Unhedged Foreign Stocks and Bonds” by Philippe Jorion, Journal of Portfolio Management, Summer 1989, p 49-54. The benefits of currency risk hedging